While recognised investment exchanges sometimes halt trading or very occasionally cancel transactions, for example as a non-regulatory circuit breaker, or when trades, known as “fat finger” trades, are placed in error, it is very rare for them to suspend trading for days, or to cancel entire trading sessions. Yet, that is what happened earlier this year at the London Metal Exchange (LME). This article considers US activist hedge fund Elliott Management’s challenge of the LME’s decision to cancel trades.

KEY POINTS

Following a period of suspension triggered by an enormous price surge, the London Metal Exchange (LME) cancelled all nickel trades placed on its exchange on 8 March; this wiped-out significant profits for base metals traders who were on the right side of a huge short position.

Elliott Management impugns that decision on the basis it was unlawful for the LME’s want of power, or because it was irrational or unreasonable. They seek a judicial review (JR) of that decision as well as substantial damages of some £326m, for profit lost from cancellation.

While decisions of the LME, which is performing a public law function, are susceptible to JR, Elliott will succeed only if its claim truly and primarily involves public law principles (as opposed to enforcement of private law rights), and if it establishes that the LME exceeded its powers, or its decisions defied logic, or were reached in bad faith.

Even if Elliott succeeds on any of those bases, it will have to show that the impugned decisions involved a breach of contract (as a matter of private law), or some other right to recover the amount claimed (eg debt, or the right to protection of property under the Human Rights Act 1998).

However, the LME rules, regulations and policies, including its power to cancel agreed trades, are incorporated in the nickel contracts traded on the LME. So, it is not unlikely that Elliott will have to rely on a term to be implied in those contracts, if it is to obtain anything like the level of damages it seeks.

On 8 March this year the London Metal Exchange (LME) in an unprecedented move suspended nickel trading for six days. This was in response to a surge in prices. The surge was caused by an enormous, short position held by Xiang Guangda; so large that it threatened to topple the LME.

Xiang, nicknamed “Big Shot” by traders in the Chinese Commodity market, is the founder of the world’s largest nickel and stainless steel producer, Tsingshan Holding Group Co. With a penchant, well known to the LME, for aggressive trades, he built the short position in the period late 2021 to early 2022. His trade was partly a hedge and partly a bet, that a planned increase in Tsingshan’s production this year would force down nickel prices to less than US$25,000 per tonne. But, on 7 March, following Russia’s invasion of Ukraine, the price of nickel started climbing –gradually at first, from around US$42,000 per tonne to a few hundred USD per tonne (within normal daily price fluctuations), before rocketing 250% in the same day, albeit briefly, to US$100,000 per tonne, before settling back to US$80,000 per tonne. This was an epic trading squeeze putting Xiang’s trade more than US$10bn underwater and precipitating a crisis not seen in the base metals market since the Tin crisis of 1985 (when trading was halted for five years).

Unsurprisingly, the volatility in the price of nickel and the suspension of its trading on 8 March wrought havoc for companies that use nickel, like stainless steel mills and makers of batteries for electric vehicles. This had the effect of heaping further pain on an already fragile global supply chain. Some companies simply stopped taking new orders. And, on the LME, dealers were left frantically trying to recoup missed margin calls from clients who could not pay, and at least one had to seek financial support from its parent company.

The LME explains that its decision to suspend trading was taken because the nickel market had quite obviously become disorderly posing a systemic risk to that market. However, when the LME lifted the suspension on 16 March, it promptly cancelled retrospectively all nickel transactions made on the first day of suspension, on 8 March. This amounted to the cancellation of trading valued at some US$3.9bn.

When pressed for a further explanation, the LME said that: “... [c]ancellations were made retrospectively to take the market back to the last point in time at which the LME could be confident that the market was operating in an orderly manner.”

The LME’s interventions, which rescued several brokers from potentially ruinous margin calls, served as a bailout of Tsingshan, its owner and its banks, while wiping out huge profits for those investors that held bullish bets.

It is against that background, that in its claim for $456m, the US activist hedge fund Elliot Management, through its affiliates, Elliott Associates LP and Elliot International LP, is seeking judicial review by the Administrative Court in London of the LME’s decision to cancel those nickel trades.

So, how likely is it that the court will order the LME to pay Elliott the money it would have received from trades it booked on the LME on 8 March? For the reasons highlighted below, it seems unlikely.

The courts will review an exercise of power to ensure that a body like the LME, performing a public law function:

- has not made an error of law;

- has considered all relevant factors, and not taken into account any irrelevant factors;

- has acted for a purpose expressly or impliedly authorised by statute;

- has not acted in a way that is so unreasonable that no reasonable public body would act in that way; and

- has observed statutory procedural requirements and the common law principles of natural justice or procedural fairness.

The LME’s owners, Hong Kong Exchanges and Clearing Ltd, have confirmed that Elliott contends in the alternative that the LME exceeded its powers when it cancelled those trades and in so doing acted unlawfully (illegality), or that it exercised its powers unreasonably or irrationally by basing its decision on irrelevant factors, including its own financial position, and failed to take other relevant factors into account. It is understood that Elliott also contends that the cancellation also constituted a violation of their human rights under the Human Rights Act 1998 (HRA) – eg it was a disproportionate interference with the right to peaceful enjoyment of possessions (economic interests), or it was discriminatory as between market participants.

There is a number of significant hurdles that Elliott will have to overcome not only if it is to succeed in challenging the LME’s decision, but also if it is to obtain an award of damages of some £326m. Five of those hurdles may be summarised as follows.

First, judicial review is available only against a public body or body performing a public law function in either case crucially in relation to a public law matter involving public law principles, not private law.

Although it has been acknowledged, albeit in relation to a case involving a public consultation, that, as a body recognised under the Financial Services and Markets Act 2000 (FSMA) established to uphold certain standards on its exchange (in accordance with the FMSA Recognition Requirements Regulations 2001), the LME’s decisions are subject to judicial review (R (on the application of United Company Rusal Plc v The London Metal Exchange [2014] EWHC 890 (Admin) (Rusal)), Elliott will have to show that, through its substantial claim in damages, which appears to be based on lost profit, it is not in fact seeking to enforce essentially private law rights, which is far from clear. As the Court of Appeal was careful to point out in Rusal:

“[w]here judicial review is sought in a commercial setting of this kind, parties may make or lose money as a result of the delay caused by a legal challenge and the regulation of the market may be undermined. Accordingly, the court has to act with considerable care lest the integrity of the market is prejudiced by an unsustainable legal challenge.” ([2014] EWCA Civ 1271, at para 89)

Second, if Elliott’s claim, that the LME’s decision to cancel nickel trades retrospectively was illegal, is to succeed, they will have to show that the LME acted beyond its powers. This is likely to be very difficult to establish. This is because the LME’s powers, contained within its Rules and Regulations, are broad and provide specifically for order cancellation and control. To make matters more difficult, those rules and regulations are expressly incorporated in exchange traded nickel contracts.

Rule 22.1, for example, states: “Where the Exchange considers it appropriate, the Exchange may cancel, vary or correct any Agreed Trade or Contract.”

That rule is supported by the following published policy: “The LME may be required to cancel orders in order to prevent disorderly trading conditions and breaches of capacity limits …

The LME may also cancel or revoke orders and trades/transactions in accordance with the LME’s policy on Error Trades and Erroneous Order Submission.”

In turn, they give effect to the following standards required by the FSMA Recognition Requirements Regulations, which are expected of the LME’s exchange:

(a) fair and orderly trading;

(b) securing the timely discharge of the rights and liabilities of the parties to transactions effected on the exchange (See Rusal at para 8).

Third, in relation to their claims, advanced in the alternative, based on unreasonableness or irrationality, Elliott will have to show that the LME’s decision to cancel the trades was made in bad faith or resulted from irrelevant factors or considerations and/or was so outrageous in its defiance of logic that no reasonable person applying their mind to the relevant issues – those with which the LME had to grapple at the time – would have arrived at the same decision (Associated Provincial Picture Houses Ltd v Wednesbury Corporation [1948] 1 KB 223). These are really very high hurdles to overcome. Key to traversing them will be the notes and minutes of the LME’s meetings leading to the impugned decision as well as whether and, if so, to what extent the disclosed evidence reveals that the LME’s view that cancellation was necessary to restore the base metals market to orderly trading was reasonably held and whether their own financial position (and/ or Tsinghan’s survival) was wrongly a factor in the LME’s decision-making, or was either irrelevant to that decision or was given disproportionate weight in the decisionmaking process.

Fourth, it is rare for damages to be awarded in judicial review actions. When, like here, compensation is sought, it is generally sought in separate court proceedings. To obtain damages, Elliott will have to establish not only that the claim for financial compensation is secondary to their public law claim, but also that the impugned decision involves a breach of contract (as a matter of private law), or some other right to recover the amount claimed (eg debt, or rights under the HRA).

The problem here is that base metals traded on the LME are subject to contracts that incorporate the LME rules, regulations, and policies, including specifically the LME’s discretion to cancel agreed trades and contracts. Thus, any argument that the LME’s decision to cancel the relevant trades and contracts was unlawful would likely have to be founded upon an implied term. However, the courts have been reluctant to imply terms into effective and coherent contractual arrangements between commercial parties. It is assumed that this is why Elliott has also brought a claim under the HRA, where damages are assessed differently.

Fifth, in relation to the HRA aspect to their claim, it is assumed that damages are claimed for breach of the right to protection of property (HRA, Sch 1, Pt II, Art 1).

While the courts have jurisdiction under s 8 of the HRA to award damages for violations of Convention rights, the finding of a violation is of itself generally considered to be an important part of the remedy and vindication of the claimant’s Convention rights. This is why the measure of damages under the HRA is different from compensatory damages. The purpose of incorporating the Convention into domestic law was intended to give victims the same remedies in the domestic courts that they could have in the European Court of Human Rights (ECHR), not to provide better remedies.

Consequently, the HRA requires domestic courts to look at the principles established by the ECHR. Although the fundamental principle underlying the ECHR jurisprudence is that the courts should seek to restore a claimant to the position they would have been in if there had been no breach of their Convention rights, awards should be those considered equitable, that is fair to the individual in the particular case having regard to the gravity and severity of the violation and its impact on the individual, but without being precisely calculated, rather than having regard to the level of damages that might be payable for comparable domestic torts and contract breaches.

So, Elliott will have to show not only that the LME’s decision was incompatible with its (Art 1) Convention right(s), but also that it amounted to a serious breach (that cannot be justified in the public interest) in relation to which their damages claim, if awarded, would in all the circumstances be equitable.

Compared with Xiang Guangda’s short position, Elliott’s bet, that they will succeed in their Judicial Review claim and obtain the damages sought, although apparently highly speculative, will, if they lose, be a tiny fraction of the cost to Big Shot of his failed bet, which is estimated to have cost him US$1bn, which set the feet of this debacle running.

Anthony Dearing - December 2021 Butterworths Journal of International Banking and Financial Law